Reforming small electricity systems under political instability: The case of Nepal

Abstract

This paper assesses the issues and options in reforming small electricity sector systems in general while citing Nepal as a specific case. Political instability and increasing electricity demand are two major complicating factors in power sector reform of small systems such as that of Nepal. Lessons from international experience suggest that measures such as cost-reflecting pricing, restructuring and independent regulation are important for the success of reforms. In small systems, the creation of an independent regulatory authority is more important than unbundling of the sector. In the present context of Nepal accounting separation of the main activities may be a pragmatic restructuring approach given the present political and market condition. As the systems gradually grow larger, vertical separation of the system and horizontal splitting of the generation segment and competition in organised wholesale market followed by privatisation remains an option in the long run.

Introduction

Electricity sector reforms have remained a priority across many economies, including Nepal, since the early 1990s. Many advanced economies (such as the OECD) and over 70 developing countries had introduced some reform steps by the end of 1990s (Bacon, 1999; Steiner, 2001; Jamasb et al., 2004). However, the motives, ideology and initial contexts of reform varied across these countries although the reform aspirations were relatively similar. In developed economies, improving economic and financial efficiency was the guiding principle of power sector reform. Reforms in less-developed countries were inevitable due to the burden of price subsidies, low service quality, low bill collection rates, high network energy losses and poor service coverage experienced under the monolithic state-owned and controlled systems (Joskow, 1998, Newbery, 2002, Jamasb, 2006).

The institutional framework, regulatory arrangements, political ambience and market structures also varied across the countries partly depending upon the size of the sector. Electricity sectors of many developing countries, including Nepal, can be regarded as ‘small systems’ (Kessides, 2004). As of 2004, 60 developing countries had peak system loads that were below 150  megawatts (MW); another 30 countries between 150 and 500 MW, and possibly another 20 countries are between 501 and 1000 MW (Bacon, 1999). However, increasing population and load implies that many small power systems will not remain small but over time they will grow from their current size. As such, the peak load in Nepal is also projected to increase to 2206 MW by 2020 and 3679 MW by 2030 (NEA, 2010).

Meeting the rapid growth in electricity demand remains a major challenge facing the Nepalese electricity sector. Despite being endowed with large water resources, the vertically-integrated system has developed only around 0.72 GW out of potential 40 GW of generation capacity including those of the Independent Power Producers (IPPs) since the establishment of Nepal Electricity Authority (NEA) in 1985 (Joshi and Khadka, 2009). Political instability in the form of ‘civil war’² that spanned for eleven years derailed the development of hydropower in Nepal. NEA, operating under a single-buyer model (SBM), is not immune to political intervention and corruption in the Nepalese context. The political leadership has changed 11–12 times in the last decade with Nepal being the world's most recent republic in 2008. Political instability has severely affected the predominantly state owned sector resulting in discontinued policies, uncertainty and weak and often stalled implementation of reform. Thus, the current organisation and structure of the electricity sector can be regarded as uncertain and unsustainable after more than two decades of reform.

The aim of this paper is to assess the performance of the Nepalese power sector under various reforms since the establishment of NEA. The contributions of this paper are two-fold. Firstly, this paper provides important electricity reform lessons for several monolithic state-owned and controlled ‘small systems’ in Asia and Africa reeling upon growing political instability. Experience with reforms in South Asian neighbours³ as well as successful electricity reforms in several Latin American countries (LACs) such as Chile, Argentina and Brazil are discussed. These LACs successfully reformed from having a small power sector towards a large one in the last two decades. Thus, the lessons learnt from these countries provide a useful guidance to ‘small systems’ like Nepal whose electricity sector will have to grow under increasing population and economic growth. Secondly, the paper fills the existing gap in the literature regarding a comprehensive study of the power sector reform processes in Nepal over the years.

The paper is organised as follows. Section 2 presents the economic arguments related to reforms in small power systems. Section 3 briefly discusses the sequence and contents of the main electricity reform initiatives in Nepal after 1990. In Section 4, the major economic, operational and environmental consequences of power sector reforms from 1990 till 2008 are evaluated. Section 5 discusses the multi-stage reform options addressing the concerns of high political volatility and growing electricity demand. Finally, Section 6 concludes and offers some policy recommendations.